Italian loan sale market heats up

Italy’s banks are finally putting non-core loans onto the market, writes Lauren Parr.

One of Europe’s biggest non-performing loan opportunities is finally emerging, with Italian banks beginning to dispose of non-core real estate loans.

Activity began around two years ago, although portfolios tended to be small-scale and comprised of unsecured positions. The market looks very different today. Last December, the Italian government approved a €20 billion bailout of the country’s worst-performing banks, including Monte dei Paschi di Siena. Most lenders are attempting to get to grips with their NPL holdings.

Meanwhile, investors are positioning themselves to tap into the NPLs Italian banks still hold on balance sheet, estimated by the Bank of Italy to total €200 billion.

“Every week we meet with investors old and new interested in the Italian market, asking for secured real estate portfolios,” says Andrea Calzavacca, senior analyst for loan portfolio advisory at CBRE Capital Advisors’ Milan office. “They know there has been a change in the banking environment and banks have to dispose of assets to clean up their books.”

Two years ago, banks were defiant. “All of the banks were fine with their positions, claiming they had a lot of provision and so on,” Calzavacca recalls. The European Central Bank’s Asset Quality Review dispelled that myth, revealing a major capital shortfall in the country’s banking system.

Definitive moves are being made by banks to tackle their toxic loan piles. In March, Monte dei Paschi approved a business plan to dispose of its entire circa €30 billion NPL book. The top five largest banks hold 65 percent of NPL stock, according to Bank of Italy data. As part of a programme aimed at improving its capital position, UniCredit offloaded €17.7 billion of NPLs in one transaction – Project Fino – to Fortress and PIMCO at the end of last year, of which up to €6 billion comprised secured debt.

That deal propped up the €36 billion of loan sale activity recorded in Italy in 2016 across all asset types by Deloitte. It was a significant rise on 2015’s €10 billion, but less than had been anticipated for last year.

Volumes were affected by the uncertainty linked to Italy’s constitutional referendum, the loss of which prompted Matteo Renzi to resign as prime minister, as well as a continued discrepancy between buyers’ and sellers’ price expectations. Furthermore, a change in law making it easier to foreclose on assets was not passed until May (see panel).

Market watchers expect 2017 to be the busiest year yet, with Deloitte noting €39.7 billion of ongoing sales. Several portfolios have hit the market (see p. 20), including the first totally secured portfolio; Banco BPM’s Project Rainbow. With a gross book value of €770 million linked to just 50 borrowers, around a third of which is backed by hotels, bids have flooded in. In the region of 20 non-binding offers have reportedly been received.

“Banks are getting organised and investors are sorting themselves out,” says Francesca Galante, co-founder of real estate debt advisor First Growth Real Estate. US investor CarVal is raising €400 million in partnership with Italian asset manager Fondaco to invest in performing and non-performing real estate loans in Italy, for example.

“There’s quite a lot to do; even if you look at the smaller banks, on aggregate they have about €8.5 billion secured [by real estate],” adds Galante.

The bulk of NPL sales have related to unsecured consumer and corporate loans so far. However, the market is maturing and a greater number of portfolios including real estate debt are coming to the market in response to investor demand. Regional Italian bank Banca BPER reached an agreement to sell only the good half of a €1 billion mixed credit portfolio it initially tried to shift last year.

Intesa Sanpaolo is in talks with between five and seven potential joint venture partners on a secured credit portfolio of €1.3 billion. Project REP will emulate the deal UniCredit struck with PIMCO and GWM last year, whereby the bank retained a minority stake in a €1.2 billion NPL book known as Project Sandokan.

Investors are making in-roads into the market. In February, Bain Capital Credit acquired Heta Asset Resolution Italia, a manager of distressed loans, as part of its plan to scale its services in the country with a view to potentially originating loans in the long-term future. Heta is a bad bank established by the Austrian government to wind-down the non-performing loans on the balance sheets of Hypo Alpe Adria, now known as Harit.

Investors must be armed with time, money and patience to go through the bidding and underwriting process, as the level of information attached to NPL sales is extremely poor. “You don’t know the quality of underlying assets until you underwrite them,” Galante says. In her experience of Italian NPL portfolios “it’s a real mixed bag”.

Secured debt comprises around 45 per cent of banks’ NPL books, according to the Bank of Italy, and the largest portion relates to unfinished holiday homes scattered across the country. The draw for investors is “a handful of cherries in a portfolio” that can be picked up at steep discounts, say Calzavacca. “There are a lot of strong hotel assets, some of which may be poorly managed.”

Underlying property portfolios tend to be very granular which makes working them out much more difficult. Moreover, the choice of servicers is sparse. “Servicers owned by Italian banks or listed entities are the only game in town, and they don’t practice what we would consider international investment banking standards,” says Clarence Dixon, global head of loan servicing at CBRE Capital Advisors.

The importance of understanding the local market was no doubt a factor in KKR’s purchase of a stake in Italian loan servicing firm Sistemia in April.

The market has some way to go before bigger volumes unfold given that the country’s problem loans sit within individual banks rather than a structured bad bank. “It won’t be a straight up deleveraging like we saw with Lloyds. Some Italian banks have taken write-downs, but you’ll see a lot of transactions where they will sell off portfolios with a servicing component and keep a stake in the business,” says Dixon.

Enforcement reforms only go so far

One of the biggest challenges of buying NPLs backed by Italian property is the country’s notoriously slow enforcement process. Former prime minister Matteo Renzi attempted to address this with reforms including amendments to bankruptcy and foreclosure proceedings. A 2016 reform – Patto Marciano – is designed to allow lenders to bypass court proceedings to seize a borrowers’ property if a loan defaults.

The reforms have not been a game-changer, however. “Timing remains difficult. A lot of investors are saying it’s not a problem to have a long business plan; the real problem is not having a certain timeframe,” says CBRE Capital Advisors’ Calzavacca.

An investor buying loans in the Netherlands, for example, would know it takes 12-24 months to work assets out, and could calculate the costs in doing so, identifying an expected return at specific point in the future. In Italy that’s not possible; it could take longer to enforce on an asset in southern Italy than northern Italy.

“The legislation goes in the right direction but we haven’t seen the outcome of it yet; it’s untested,” says Galante of First Growth.

The government also initiated a scheme in 2016 under which banks can offload bad loans through securitisations backed by state guarantee, making it easier to sell to private investors. Bonds are not in high demand though, given the unpredictable repayment profile compared to other government debt. “It does not represent the silver bullet to Italy’s problems,” says Calzavacca.